How Much Is A Breaching Partner Worth?

When you operate a business with another person, New York considers you to be in a general partnership unless you form an entity like a corporation or limited liability company. Without a written Partnership Agreement, you can leave the partnership at any time. However, if you and your partners enter into a Partnership Agreement, then as with any contract, you need to follow its terms in order to lawfully terminate the partnership.
In the event that a partner dissolves the partnership in contravention of the Partnership Agreement, New York Partnership Law Section 69(2)(a)(II) permits the non-breaching partners to have a claim for damages for breach of the Partnership Agreement. In addition, Section 69(2)(b) permits the non-breaching partners to continue the partnership business.  Under Section 69(2)(c)(II),  the  partner who wrongfully dissolved the partnership is entitled to be paid the value of his interest in the partnership, not including the partnership’s “good will” (i.e., some of the intangible assets of the business, such as its trade name, reputation and client base), less any damages caused by his breach, and thereafter to be released from the liabilities of the partnership.
In a case that William Quackenbush, ASA, MCBA, ABAR provided expert witness testimony, there was a 3-person partnership, the partnership agreement of which provided that the partnership would continue for 50 years. For various reasons, two partners voted to dissolve the partnership before that time, which was a breach of the Partner- ship Agreement. This led to a lawsuit commenced by the “non-breaching partner.” The non-breaching partner elected to continue the partnership business under Section 69(2)(b). Therefore, the breaching partners were entitled to be paid their interest in the partnership. But, Partnership Law Section 69 does not specifically provide for the method of valuation of a partner’s interest.
So, how do you value the breaching partner’s interest? In a case of first impression in the non- breaching partner’s attorney successfully argued that fair market value of the partnership’s assets is the correct valuation method to determine the value of the partner’s interest in the partnership business.
Here, the non-breaching partner argued that the breaching partners’ interests should be valued at book value based upon the accounting principles commonly used by the partnership. However, the non-breaching partner was the person primarily responsible for the financial books and records of the partnership for the tenure of the business, and employed book value accounting principles for its records. He also argued that the Partnership Agreement provided for an exiting partner to receive book value for his interest.
The non-breaching partner’s attorney argued that the Partnership Agreement did not govern this situation because it only provided for a partner to be paid book value for his interest in the event that the partner retired or died, or the business was liquidated and sold following the retirement or death of a partner and the remaining partners choose not to continue the business. None of these events occurred because the breaching partners voted to dissolve the partnership and the non-breaching partner elected to continue the business.
The non-breaching partner’s attorney collaborated with a CPA and William Quackenbush, ASA, MCBA, ABAR, the managing director of Advent Valuation Advisors. Both experts testified that book value accounting is not a valuation convention, but an accounting convention that significantly depreciates an entity’s assets and does not reflect the company’s true value. Mr. Quackenbush opined that the language of Section 69 supported a fair market valuation. Both Mr. Quackenbush and the CPA also testified that the poor bookkeeping practices of the partnership prevented a true market value analysis. Mr. Quackenbush testified that the partnership’s recorded value of the machinery and equipment and inventory needed to be adjusted to fair market value to reflect a realistic value of the company.
Ultimately, the Appellate Division, Second Department, adopted the arguments asserted by the non-breaching partner’s attorney, holding that, “The Supreme Court did not improvidently exercise its discretion in using fair market value to determine the value of each defendant’s interest in the subject partnership pursuant to Partnership Law Section 69 (2). It is undisputed that the defendants wrongfully dissolved the subject partnership. The parties’ partnership agreement did not limit the interest of a partner who wrongfully dissolved the partnership to book value, and book value is an accounting method that does not reflect fair market value of an asset.”